The Power of the People

On Sunday the Conservative Party in the United Kingdom introduced the concept of a “people’s bank bonus.” Party representatives justified the move by stating, “Taxpayers bailed out the banks, so they deserve a ‘people’s bank bonus’ when the time comes to sell the government shares.” The basic concept is that once Royal Bank of Scotland (government owns 84% stake) and Lloyds (government owns 41% stake) stabilize and recapture market value, the government would offer its shares to the people at a discount rate (see here). Some apparently suggest that the government should even endow the shares to the people (see here).

This announcement is just the latest example of the intense public outrage and related public and political responses to the economic crisis and bank bailouts in the United Kingdom. Admittedly, factors leading to the economic crisis have outraged people across the globe, but I have been intrigued by the passionate U.K. outcry. Perhaps it is because many outsiders view people in the United Kingdom as being more reserved and less emotional in the public forum. That image does not quite fit with the popular U.K. game “Whack a Banker” in which “[y]ou pay 40p to hit as many bankers as you can in 30 seconds as their heads pop up. It’s based on an older game called ‘Whack a Mole’.” (See here.) There also is an online version of the game. (See here; beware, slightly graphic.)

The rally cry of the people encouraged the bank bonus tax announced by the U.K. finance minister in December (see here), additional bonus restrictions that limit the cash component and permit amounts to be clawed back (see here) and a British singer to threaten withholding his own taxes until the government regulated excessive bank bonuses (see here and here). The CEOs of Lloyds, Royal Bank of Scotland and certain other banks have waived their 2009 bonuses. (For an interesting article suggesting that the focus on bonuses is misplaced, see here.) And, according to a recent survey, the U.K. public anger continues to linger. In fact, several companies are hoping to take advantage of public discontent to break into the retail banking market. As I noted in a prior post, it remains to be seen whether any of the noise surrounding the economic crisis will result in long-term change, but it certainly has generated a lot of activity across the pond.

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2 Responses

Michelle–This subject is vastly more complex than it seems to the “populists” who like to vent their rage. I am glad you posted this item, because it gives a view into a problem that seems to engender oversimplification, and the Cardiff Business School paper you cited is a perfect example.

>>Abstract: …In this paper we argue that the cushioning of banks downside risks provide the incentive for banks to take excessive risk and design compensation packages to deliver high returns. Macro-prudential regulation will have a better chance of curbing excess risk taking than controlling banker’s compensation.>>[FALSE DICHOTOMY]

Diet and exercise are the most important factors in controlling Type II Diabetes. This does NOT mean, however, that I ought to ignore my Metformin and simply exercise more.

I think that, instead of the author’s simplistic “either-or” view, what has a better chance is a more complex program in response to a very complex problem.

>>1. Introduction: …The popular view is that bonuses have encouraged bankers to take risky positions with the aim of making short-term profits. …

This paper argues that banker’s bonuses are an effect and not a cause of excessive risk taking by the banks.>> [FALSE DICHOTOMY]

Here the author inserts a dichotomy that NOBODY claims. Everybody from Pavlov to the present time knows that there are two diametrically opposite “cause-effect” relationships in human behavior. When Action A produces Positive Reinforcement R, then the subject will do A. “A causes R” in the physical sense, and “R causes A” in the motivational sense.

>>In the parlance of economic modelling, both compensation and risk taking are endogenous variables.>>

Oh c’mon, don’t try to snow me with vocabulary, try to convince me with logic. First of all, that term “endogenous” doesn’t mean “it doesn’t count.” Far from it, endogenous variables are often the independent and dependent variables of significance in meaningful models. Rather, in many cases it means that those two variables exhibit a relationship that may be dependent, as well, on some other omitted variable. Secondly, that omitted variable may not be invisible, or even difficult to account for, but simply doesn’t appear in the function(s) of the model.

In such a case, the appropriate approach to improving the model is not to ignore the “endogenous” variables and simply focus on the omitted variable. Rather, it is to include the omitted variable in a more complex formulation of the model. There is a clear and concise article on this subject in Wikipedia: http://en.wikipedia.org/wiki/Endogeneity_(economics)

In this case, I posit that the omitted variable (in the simplistic formulation of the problem) is the set of computation factors in the compensation arithmetic. Since the compensation function has multiple variables, there are many opportunities to vary the factors to emphasize certain “desirable objectives.” But first the Board of Directors has to come to grips with the desirability of multiple objectives, which are sometimes at odds with one another, like this year’s profits and next year’s security.

…which is why I keep coming back to “this is a complex problem.”

>>The driving factor is the widespread expectation that banks in the UK are ‘too-big-to-fail’ (TBTF).>>

“The driving factor???” Gimme a break! I set up a physical Activity-Reward experiment. I put the squirrel in a cage with a big red pedal. When the squirrel presses the pedal, a reward pellet drops from the pellet supply (outside the cage) into the reward tray (inside the box). The squirrel pounds away at the pedal, getting his rewards in proportion to his frenetic activity.

And you think the driving factor is how many pellets are available in the supply cannister?

A wonderful comment; thank you. In posting items, I try to pick topics that will generate a discussion and help flesh out complex issues. I also frequently try to mute my voice so that I can clearly hear others. And this is a great example.

I completely agree with you that the issue of bonus and compensation structures is far more complex than many will acknowledge. And although simplification often can help you understand the origin of a problem, it also can cause you to miss critical contributing factors. I think the issues we face in the bonus/compensation context require an indepth analysis from multiple vantage points, including a pure economic and a behavioral perspective. It is similar to the issues I raised in a prior post in the context of risk management; only by understanding the whole can you start to fix the parts so to speak.